GAAP established a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy categorizes the inputs into three levels with the highest priority given to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority given to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:

Level 1 - Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Level 1 primarily consists of financial instruments such as exchange-traded derivatives and listed equities. Equity securities that are also classified as cash equivalents are considered Level 1 if there are unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 - Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. Instruments in this category include non-exchange-traded derivatives such as over-the-counter forwards and options.

Level 3 - Pricing inputs include significant inputs that have little or no observability as of the reporting date. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. If a fair value measurement relies on inputs from different levels of the hierarchy, the entire measurement must be placed based on the lowest level input that is significant to the fair value measurement. The Company primarily determines fair value measurements classified as Level 2 or Level 3 using a combination of the income and market valuation approaches. On a daily basis, the Company obtains quoted forward prices for the electric and natural gas market from an independent external pricing service. These forward price quotes are used in addition to other various inputs to determine the reported fair value. Some of the inputs include the credit standing of the counterparties involved and the impact of credit enhancements (such as cash deposits, letters of credit and priority interests), assumptions for time value, and also the impact of the Company's nonperformance risk of its liabilities.

As of June 30, 2011, the Company considered the markets for its electric and natural gas as Level 2 derivative instruments, since such contracts are commonly traded as over-the-counter forwards with indirectly observable price quotes. Management's assessment was based on the trading activity volume in real-time and forward electric and natural gas markets. The Company regularly confirms the validity of pricing service quoted prices (e.g., Level 2 in the fair value hierarchy) used to value commodity contracts with the actual prices of commodity contracts entered into during the most recent quarter.

The following tables present the Company's financial assets and liabilities by level, within the fair value hierarchy, that were accounted for at fair value on a recurring basis and the reconciliation of the changes in the fair value of Level 3 derivatives in the fair value hierarchy as of June 30, 2011 and December 31, 2010:

Puget Energy	Fair Value Measurement at June 30, 2011								Fair Value Measurement at December 31, 2010
(Dollars in Thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Electric derivative instruments	$	--	$	1,675	$	7,770	$	9,445	$	--	$	1,874	$	7,888	$	9,762
Gas derivative instruments		--		2,345		6,092		8,437		--		1,487		4,484		5,971
Cash equivalents		5,606		4,779		--		10,385		15,184		5,450		--		20,634
Restricted cash		2,340		--		--		2,340		3,246		--		--		3,246
Total assets	$	7,946	$	8,799	$	13,862	$	30,607	$	18,430	$	8,811	$	12,372	$	39,613
Liabilities:
Electric derivative instruments	$	--	$	113,297	$	89,064	$	202,361	$	--	$	147,257	$	95,324	$	242,581
Gas derivative instruments		--		100,603		6,335		106,938		--		147,308		8,343		155,651
Interest rate derivative instruments		--		53,816		--		53,816		--		58,003		--		58,003
Total liabilities	$	--	$	267,716	$	95,399	$	363,115	$	--	$	352,568	$	103,667	$	456,235

Puget Sound Energy	Fair Value Measurement at June 30, 2011								Fair Value Measurement at December 31, 2010
(Dollars in Thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Electric derivative instruments	$	--	$	1,675	$	7,770	$	9,445	$	--	$	1,874	$	7,888	$	9,762
Gas derivative instruments		--		2,345		6,092		8,437		--		1,487		4,484		5,971
Cash equivalents		--		4,779		--		4,779		15,184		5,450		--		20,634
Restricted cash		2,340		--		--		2,340		3,246		--		--		3,246
Total assets	$	2,340	$	8,799	$	13,862	$	25,001	$	18,430	$	8,811	$	12,372	$	39,613
Liabilities:
Electric derivative instruments	$	--	$	113,297	$	89,064	$	202,361	$	--	$	147,257	$	95,324	$	242,581
Gas derivative instruments		--		100,603		6,335		106,938		--		147,308		8,343		155,651
Total liabilities	$	--	$	213,900	$	95,399	$	309,299	$	--	$	294,565	$	103,667	$	398,232

Puget Energy and Puget Sound Energy Level 3 Roll-Forward Net (Liability)	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in Thousands)	2011			2010			2011			2010
Balance at beginning of period	$	(91,543	)	$	(128,835	)	$	(91,295	)	$	(100,333	)
Changes during period:
Realized and unrealized energy derivatives
- included in earnings		(4,244	) 1		(10,017	) 2		(19,951	) 1		(79,616	) 2
- included in regulatory assets / liabilities		1,860			(644	)		2,979			(839	)
Settlements 3		7,107			5,512			17,547			13,340
Transferred into Level 3		363			(536	)		363			(536	)
Transferred out of Level 3		4,920			(601	)		8,820			32,863
Balance at end of period	$	(81,537	)	$	(135,121	)	$	(81,537	)	$	(135,121	)

1	Includes unrealized gains (losses) on derivatives still held in position as of the reporting date for electric and gas derivatives of $(3.1) million and $(1.9) million, respectively, for the three months ended June 30, 2011 and $(17.5) million and $(0.8) million for electric and gas derivatives for the six months ended June 30, 2011, respectively.
2	Includes unrealized gains (losses) on derivatives still held in position as of the reporting date for electric and gas derivatives of $(3.9) million and $(6.2) million, respectively, for the three months ended June 30, 2010 and $(39.3) million and $(28.0) million for electric and gas derivatives for the six months ended June 30, 2010, respectively.
3	The Company had no purchases or issuances during the reported periods.

Realized gains and losses on energy derivatives for Level 3 recurring items are included in energy costs in the Company's consolidated statements of income under purchased electricity, electric generation fuel or purchased natural gas when settled.

Unrealized gains and losses on energy derivatives for Level 3 recurring items are included in net unrealized (gain) loss on derivative instruments in the Company's consolidated statements of income. Certain energy derivative instruments are classified as Level 3 in the fair value hierarchy since Level 3 inputs are significant to the fair value measurement. Energy derivatives transferred out of Level 3 represent existing assets or liabilities that were classified as Level 3 at the beginning of the reporting period for which the lowest significant input became observable during the current reporting period and were transferred into Level 2. Conversely, energy derivatives transferred into Level 3 from Level 2 represent scenarios in which the lowest significant input became unobservable during the current reporting period. The Company did not have any transfers between Level 2 and Level 1 during the three and six months ended June 30, 2011 or 2010.